## _cr08278

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---

### Executive Summary — Context and Recent Developments
- Growth slowed to 2.7 percent in 2007 after robust expansion in 2004-06, with capacity constraints and external uncertainties.
- Employment growth reached 2 percent a year; unemployment declined from 8 percent in 2005 to 6 percent in early 2008.
- Wages accelerated while labor productivity slowed; unit labor costs increased when labor productivity fell at the peak of the labor cycle.
- Inflation picked up from ½ percent in 2005 to 4 percent in May 2008; the core rate rose to 2.9 percent.
- Fiscal and external current account surpluses remain high; gross public debt is falling below 40 percent of GDP.
- Banks resilient so far but vulnerabilities rising with large regional exposure; share prices dropped compared to Nordic indices and average CDS spreads have risen.

### Outlook and Medium-Term Projections
- Short-run outlook:
  - Economy expected to slow below potential in 2008, with a recovery beginning in 2009.
  - Authorities and staff project growth of 2 percent in 2008 and 1¾ percent in 2009.
- Medium-term:
  - Medium-term potential growth projected to ease to 2-2¼ percent; long-run potential growth likely ranges from 2-2¼ percent.
  - Assumed TFP growth levels off at 1.1 percent a year going forward.
- Selected staff projections (Real GDP and key items, percent):
  - Real GDP: 2007: 2.7; 2008: 2.0; 2009: 1.7; 2010: 2.8; 2011: 3.0; 2012: 2.8; 2013: 2.5
  - Final domestic demand: 2007: 3.2; 2008: 2.1; 2009: 1.8
  - Consumption: 2007: 2.4; 2008: 1.9; 2009: 2.2
  - Fixed investment: 2007: 8.0; 2008: 4.1; 2009: 1.2
  - Net exports contribution: 2007: 2/ -0.9; 2008: 0.1; 2009: -0.4
  - Exports: 2007: 6.0; 2008: 5.8; 2009: 2.4
  - Imports: 2007: 9.6; 2008: 6.8; 2009: 3.7
  - CPI inflation, pa: 2007: 1.7; 2008: 3.4; 2009: 2.8
  - Unemployment rate, pa: 2007: 6.1; 2008: 6.6; 2009: 7.1
  - Potential growth: 2007: 3.4; 2008: 3.2; 2009: 2.8
  - Output gap: 2007: 0.7; 2008: -0.5; 2009: -1.6
  - Current account balance: 2007: 8.4; 2008: 7.5; 2009: 6.8
- Risks:
  - 2008 risks to growth are balanced.
  - 2009 risks hinge on banking developments: normalization of funding and a Baltic soft landing support growth; persistent turmoil, housing price declines, or souring Baltic exposures could trigger a credit crunch and slower growth.

### Financial Sector Surveillance and Risks
- System structure and performance (four dominant banks: Nordea, SEB, Swedbank, Handelsbanken):
  - Return on assets: 0.6, 0.7, 0.8, 0.8, 0.8 (2003–2007).
  - Return on equity: 12.5, 15.9, 18.1, 19.9, 18.5 (2003–2007).
  - Regulatory capital to risk-weighted assets: 10.5, 10.6, 10.5, 10.5, 10.2 (2003–2007).
  - Regulatory Tier 1 capital to risk-weighted assets: 8.0, 8.3, 7.7, 7.8, 7.5 (2003–2007).
  - Capital to assets (1/leverage): 5.1, 4.8, 4.8, 4.8, 4.7 (2003–2007).
  - Nonperforming loans to total gross loans: 2.0, 1.2, 0.9, 0.8, 0.6 (2003–2007).
  - Noninterbank loans to noninterbank deposits: 142.6, 130.8, 137.4, 135.7, 139.8 (2003–2007).
  - Tier 1 capital adequacy: 7 percent. Overall risk-weighted CARs: 10 percent.
- Baltic exposure and funding risks:
  - Swedbank and SEB: up to two-thirds lending market share in Baltics; each earns about a third of operating profits in the Baltics with 11 percent of total lending there (in euros and local currency).
  - Direct exposure to Baltics (in % of group assets) examples shown for SEB and Swedbank: cumulative 5.2% of total assets; cumulative 20% of total assets for the two largest exposures.
  - Sweden represents 31% of total foreign bank funding to the Baltics; Germany 16%, Italy 11%, France 3%, Belgium 7%, Other 32%.
  - Banks rely importantly on wholesale and securities-related borrowing (in euros, krona, and local currency); funding has tightened and become more costly.
  - Banks partially switched to covered mortgage bonds with double collateral and longer average maturities.
- Market signals and stress indicators:
  - Stock prices have dropped and credit default swap spreads have increased, notably for banks active in the Baltics.
  - Despite deterioration, system remains sound with 10 percent of banking assets at risk if banks with investment grade or lower credit rating default.
  - Default probability of Swedish banks remains low compared to other large banks.
- Staff recommendations on capital and stress testing:
  - Banks should not lower capital/asset ratios further (i.e., increase leverage), even if Basel II may allow lower risk-weights for mortgage lending.
  - Stress tests indicate banks have sufficient buffers to cover loan losses up to 20 percent of total Baltic exposure while still meeting minimum CARs.
  - Stress-test scenarios should contemplate “tail” risks combining concurrent shocks.

### Bank Supervision and Resolution — Gaps and Core Recommendations
- Supervision:
  - The Financial Supervisory Authority (FSA) is enhancing cross-border supervisory cooperation and moving toward supervisory colleges in the Baltics.
  - Basel II implementation underway; eight banks permitted to use internal risk-based models.
  - Staff recommends greater use of Pillar II and stress testing, more on-site inspections of credit policies and portfolios, and less reliance on auditors’ reports.
  - FSA needs adequate resources to address high staff turnover.
- Remedial and resolution framework deficiencies:
  - Current bank resolution falls under regular corporate law, which is too slow for prompt remedial action and payments system needs.
  - Responsibilities among the FSA, Riksbank, Deposit Insurance Agency, and fiscal authorities are not clear.
  - 1990s crisis facilities are no longer in place; relying on that approach is risky given larger, cross-border banks.
- Staff core recommendations for a new framework (key features):
  - Provide the FSA authority and tools for a coherent, graduated framework from early consultation to decisive bank resolution measures.
  - Base framework on written code that defers to specialized courts to ensure timely judicial oversight without blocking supervisory decisions.
  - Include all banks to avoid special treatment for systemic banks.
  - Upon license revocation, authorities should take effective control, replace management, and trigger the deposit guarantee.
  - Authorities should have a wide range of tools to wind up failing institutions (partial sale of assets, arrange acquisition/merger, other resolution tools).
  - Owners of a failing bank should take the first hit; legislation should prescribe a clear and credible priority of claims on bank assets.
- Authorities’ position:
  - Broad agreement with staff recommendations; investigating details. Intent to keep legislation under corporate law while establishing specialized courts; consideration of applying framework only for systemic banks; assessing legal possibilities vis-à-vis European law.

### Exchange Rate Surveillance and Competitiveness
- Regime and dynamics:
  - The krona is freely floating; at constant REER the external surplus would remain high and the IIP turn positive.
  - REER is expected to increase as fiscal tightening ends and policy interest rates are higher on average than in the past—supporting the krona and reducing the current account surplus over time.
- Valuation assessments:
  - CGER analysis suggests the krona is 10-15 percent below its expected medium-term value.
  - Box 2 — CGER estimates:
    - Macroeconomic balance approach: Swedish (norm) current account surplus of 3.2 percent of GDP. Using Sweden-specific elasticities, the REER would need to appreciate 12 percent to lower the surplus to the norm.
    - Equilibrium real exchange rate approach: REER appears 16 percent below its estimated medium-term equilibrium value.
    - External sustainability approach: finds 23 percent undervaluation.
- Policy-mix implications:
  - Interaction of tight fiscal policy and loose monetary policy contributed to a softer krona and a larger external balance.
  - Fiscal and monetary policies should recalibrate: fiscal policy has room to support domestic demand in a slowdown; monetary policy should be tight to lean against imported inflation and unwind elevated inflation expectations.
  - A firmer krona should help lean against foreign price increases as domestic demand finds support and interest rates stay firm.

### Monetary Policy — Framework, Stance, and Guidance
- Framework:
  - The Riksbank targets 2 percent CPI inflation with a margin of ± 1 ppt.
  - Publishes policy committee minutes with attribution, a three-year inflation forecast and corresponding policy interest rate path.
- Stance and timing:
  - Repo rate raised by 2.75 ppts since 2006 to roughly neutral; repo rate at 4¼ percent (later raised to 4.5 percent).
  - Staff recommendation: policy should be biased up until inflation expectations drop; consider a quarter point increase given risk of second-round effects.
  - Policy should not ease until inflation expectations clearly break and capacity-use and activity indicators trend down.
- Inflation and expectations:
  - Inflation jumped above 3 percent and is projected to come down gradually.
  - Inflation expectations for one-year ahead have increased above the upper inflation target band.
- Macro-financial interactions:
  - Low international interest rates and rising resource utilization contributed to higher inflation, wage settlements, inflation expectations, house prices and household credit.
  - Riksbank’s policy normalization lag relative to ECB and Fed noted.

### Fiscal Policy — Rules, 2008 Bill, Contingencies, and Labor Supply Measures
- Fiscal framework:
  - Two rules: (i) an average surplus of 1 percent of GDP over the cycle; (ii) an expenditure ceiling for central government and social security outlays.
  - Local governments have little independent financing.
- 2008 Fiscal Policy Bill:
  - Targets a surplus of 2.9 percent of GDP, with further strengthening through 2011 on current policies.
  - Centerpiece: a SEK11 billion expansion in the earned income tax deduction.
  - Tax cuts equal 0.6 percent of GDP, offset by lower disability and other entitlement outlays so structural surplus little changed in 2008.
  - Authorities project a fiscal surplus of 4 percent of GDP by 2011 on current policies.
  - Staff view: 2009 fiscal stimulus should not exceed 1 percent of GDP; recommended support could include income tax cuts and increased infrastructure, R&D, and preschooling.
- Fiscal contingencies and risks:
  - Supply reforms and entitlement cuts could lead to substitution/displacement across programs; net fiscal savings difficult to estimate.
  - Earned income deduction and household services tax credit could prove costly; sizeable surplus could trigger rent seeking.
  - Slowdown and bank risks could reduce revenue and create contingent fiscal needs.
- Fiscal measures to boost labor supply (selected measures and assessments):
  - 2007–2008 measures: expanded earned income deduction (including more generous for 65+), reduction/elimination of nonpension social contributions for specified age groups, income tax credit on household services, New Start jobs with elimination of employer social contributions, Step-In jobs for immigrants, harmonization of unemployment insurance contributions.
  - Assessment: earned income deduction removed distortions in the marginal tax schedule but income effects vary along distribution; targeted incentive programs provided net savings for central government to date, but behavioral adaptation and displacement could reduce net savings over time; avoid multiplying narrowly targeted programs.
- Public sector balance sheet, aging costs, and long-run sustainability:
  - Authorities initially estimated aging costs of 2.2 percent of GDP between 2004-50; staff independent evaluation suggests comprehensive aging costs could be as high as 8.0 percent of GDP.
  - Current net worth: staff estimated public sector capital stock with net worth around 60 percent of GDP.
  - Forward-looking: with low aging costs net worth constraint amply met; with high aging costs the net worth constraint is just met.
  - Recommendation: independent evaluation of forecasting models and assumptions for long-term aging costs; publish intertemporal public sector balance sheet annually with alternative scenarios.

### Staff Appraisal: Risks, Recommendations, and Overall Assessment
- Overall:
  - Sweden has performed well: high output and employment growth, moderate inflation, functioning financial system, solid public finances, favorable external position.
  - Addressed demographic challenges with pension reform and labor supply measures.
- Key risks and recommended actions:
  - Strengthen financial system resilience before risks rise further; complete draft law on a dedicated remedial and resolution banking framework soon.
  - Banks should bolster resilience; authorities should cement ability to deal with stress; consider FSAP update.
  - Monetary policy should be biased upward; repo interest rate is 4¼ percent and a quarter point increase should be considered (policy later raised to 4.5 percent).
  - Fiscal policy: room to respond to slowdown; staff supports reforms in the 2009 budget not exceeding 1 percent of GDP to cut taxes and increase public investment in infrastructure, R&D, and preschooling.
  - Continue structural reforms to increase employment; limit distortions and improve transparency; evaluate labor measures.
  - Government could include an intertemporal public sector balance sheet in Budget Bills, updated annually, with alternative scenarios on long-run productivity, growth, and aging costs; an independent body could prepare estimates of aging costs.

### Executive Board Assessment and Recommendation
- Directors commended Sweden’s strong performance and highlighted main challenges: strengthen financial system resilience and anchor inflation expectations.
- Recommended actions:
  - Complete and comprehensively apply the draft banking resolution law; consider an FSAP Update.
  - Ensure FSA has adequate resources and focus.
  - Use fiscal room to provide targeted stimulus up to 1 percent of GDP if needed, prioritizing infrastructure, R&D, and pre-schooling.
  - Pursue intertemporal public sector balance sheet for transparency.
  - Continue labor taxation reforms and monitor targeted programs’ costs.
- Recommendation: Sweden should remain on the 12-month Art. IV Consultation cycle.

### Key Indicators and Tables (selected exact figures preserved)
- Real GDP (selected years): 2004: 4.1; 2005: 3.3; 2006: 4.1; 2007: 2.7; 2008: 2.0; 2009: 1.7
- CPI inflation (selected years): 2004: 1.0; 2005: 0.8; 2006: 1.5; 2007: 1.7; 2008: 3.4; 2009: 2.8
- Unemployment rate (percent): 2004: 6.3; 2005: 7.6; 2006: 7.0; 2007: 6.1; 2008: 6.6; 2009: 7.1
- Current account (percent of GDP): 2004: 6.7; 2005: 6.8; 2006: 8.5; 2007: 8.4; 2008: 7.5; 2009: 6.8
- Gross public debt (percent of GDP): 2004: 51.2; 2005: 50.9; 2006: 45.9; 2007: 40.6; 2008: 35.4; 2009: 31.2
- Repo rate (year average): 2004: 2.1; 2005: 1.7; 2006: 2.3; 2007: 3.5; policy rate raised to 4.5 percent in July 2008.
- Financial soundness indicators (banks, 2003–07 examples):
  - Regulatory capital to risk-weighted assets: 10.5 (2003), 10.6 (2004), 10.5 (2005), 10.5 (2006), 10.2 (2007)
  - Regulatory Tier I capital to risk-weighted assets: 8.0 (2003), 8.3 (2004), 7.7 (2005), 7.8 (2006), 7.5 (2007)
  - Nonperforming loans to total gross loans: 2.0 (2003), 1.2 (2004), 0.9 (2005), 0.8 (2006), 0.6 (2007)
- Exchange rate:
  - Floating Exchange Rate; Skr per U.S. dollar (May 31, 2008): 6.0375
  - CGER/valuation: krona 10-15 percent below expected medium-term value; approaches find 12 percent, 16 percent, and 23 percent required appreciation in different CGER methods.

*Source: _cr08278 - Executive Summary and selected report sections*

### Executive Summary

### Executive Summary

### Context and Recent Developments
- After robust expansion in 2004-06, growth slowed to 2.7 percent in 2007 with capacity constraints and external uncertainties.
- Employment growth has been strong; employment growth reached 2 percent a year.
- Wages have accelerated, labor productivity has slowed; unit labor costs increased when labor productivity fell at the peak of the labor cycle.
- Inflation picked up: from ½ percent in 2005 to 4 percent in May 2008; the core rate rose to 2.9 percent.
- The fiscal and external current account surpluses remain high.
- Banks have been resilient to global financial turmoil so far, but vulnerabilities are rising with large regional exposure; share prices dropped compared to Nordic indices and average CDS spreads have risen.
- Key recent indicators:
  - Unemployment declined from 8 percent in 2005 to 6 percent in early 2008.
  - Capacity use was high following rapid investment expansion in 2004-07.
  - External current account surplus reached 8 percent of GDP; trade surplus is 7 percent of GDP; net factor payments contributed 2 percent of GDP; foreign aid exceeds 1 percent of GDP.
  - Gross public debt is falling below 40 percent of GDP.

### Outlook and Medium-Term Projections
- Short-run outlook:
  - The economy is expected to slow below potential in 2008, with a recovery beginning in 2009.
  - Following global financial turbulence, consumer confidence has weakened, reducing retail spending; business confidence has dropped less.
  - The authorities and staff project growth of 2 percent in 2008 and 1¾ percent in 2009.
- Medium-term:
  - Medium-term potential growth is projected to ease to 2-2¼ percent.
  - Long-run potential growth likely ranges from 2-2¼ percent.
  - Assumed TFP growth levels off at 1.1 percent a year going forward.
- Selected medium-term scenario figures (Staff projections / Table 2):
  - Real GDP: 2007: 2.7; 2008: 2.0; 2009: 1.7; 2010: 2.8; 2011: 3.0; 2012: 2.8; 2013: 2.5
  - Final domestic demand: 2007: 3.2; 2008: 2.1; 2009: 1.8
  - Consumption: 2007: 2.4; 2008: 1.9; 2009: 2.2
  - Fixed investment: 2007: 8.0; 2008: 4.1; 2009: 1.2
  - Net exports contribution: 2007: 2/ -0.9; 2008: 0.1; 2009: -0.4
  - Exports: 2007: 6.0; 2008: 5.8; 2009: 2.4
  - Imports: 2007: 9.6; 2008: 6.8; 2009: 3.7
  - CPI inflation, pa: 2007: 1.7; 2008: 3.4; 2009: 2.8
  - Unemployment rate, pa: 2007: 6.1; 2008: 6.6; 2009: 7.1
  - Potential growth: 2007: 3.4; 2008: 3.2; 2009: 2.8
  - Output gap: 2007: 0.7; 2008: -0.5; 2009: -1.6
  - Current account balance: 2007: 8.4; 2008: 7.5; 2009: 6.8

- Risks:
  - For 2008 risks to growth are balanced.
  - For 2009 risks depend on banking developments: if funding costs normalize and the Baltics achieve a soft landing, growth could be supported; if turmoil persists, housing prices fall, and/or Baltic exposures sour, a credit crunch could slow growth below forecast.

### Financial Sector Surveillance and Risks
- While bank risk profiles are increasing, interlocutors were confident that capital buffers are sufficient to absorb stress, should it come—the staff still sees risks.
- Sweden’s bank resolution framework is deficient and needs to be updated and strengthened as a priority.
- The authorities are working on strengthening cross-border supervisory coordination.
- Financial market signals:
  - Share prices have dropped relative to Nordic indices; average CDS spreads have risen, reflecting repricing of risk and weakening growth in the Baltics.
- Staff view: growing bank vulnerabilities require close monitoring.

### Exchange Rate and Competitiveness
- The krona reflects market forces but is below its estimated medium-term value, and hence is expected to appreciate gradually.
- Competitiveness is strong.

### Monetary Policy
- The Riksbank has raised the policy rate by 2.75 ppts since 2006 to roughly neutral (repo rate at 4¼ percent).
- Recommendation: Policy should be biased up until inflation expectations drop.
- The Riksbank is monitoring second-round effects from wage and price developments.

### Fiscal Policy
- Fiscal policy remains strong; the balance exceeds the 1-percent-of-GDP surplus rule over the cycle.
- The 2008 budget reduces taxes and welfare benefits to sharpen incentives to work, and seeks to privatize some public enterprises.
- The staff agrees that the 2009 budget has room to support domestic demand and foster supply improvements.
- Increasing labor participation to support the welfare state is emphasized, given population aging.
- Historical fiscal context:
  - Sweden’s fiscal recovery since the crisis in the 1990s (deficit reached 10 percent of GDP then) has been expenditure-led; recent performance experienced buoyant revenues.
  - Primary expenditure cuts facilitated the turnaround; revenue pressure has been reduced; gross public debt is on its way down.

*Source: _cr08278 - Executive Summary*

### 15. With the economy in good shape, discussions focused on managing risks to

### _cr08278 - 15. With the economy in good shape, discussions focused on managing risks to

### Financial Sector Surveillance — Bank soundness
- System structure and performance
  - Four dominant banks: Nordea, SEB, Swedbank, and Handelsbanken have significant cross-border exposures and have expanded aggressively abroad.
  - Return on assets: 0.6, 0.7, 0.8, 0.8, 0.8 (2003–2007).
  - Return on equity: 12.5, 15.9, 18.1, 19.9, 18.5 (2003–2007).
  - Regulatory capital to risk-weighted assets: 10.5, 10.6, 10.5, 10.5, 10.2 (2003–2007).
  - Regulatory Tier 1 capital to risk-weighted assets: 8.0, 8.3, 7.7, 7.8, 7.5 (2003–2007).
  - Capital to assets (1/leverage): 5.1, 4.8, 4.8, 4.8, 4.7 (2003–2007).
  - Nonperforming loans to total gross loans: 2.0, 1.2, 0.9, 0.8, 0.6 (2003–2007).
  - Noninterbank loans to noninterbank deposits: 142.6, 130.8, 137.4, 135.7, 139.8 (2003–2007).
  - Tier 1 capital adequacy: 7 percent.
  - Overall risk-weighted CARs: 10 percent.
- Baltic exposure and funding risks
  - Swedbank and SEB: up to two-thirds lending market share in Baltics; each earns about a third of operating profits in the Baltics with 11 percent of total lending there (in euros and local currency).
  - Direct exposure to Baltics (in % of group assets) examples shown for SEB and Swedbank: cumulative 5.2% of total assets; cumulative 20% of total assets for the two largest exposures.
  - Sweden represents 31% of total foreign bank funding to the Baltics; Germany 16%, Italy 11%, France 3%, Belgium 7%, Other 32%.
  - Banks rely importantly on wholesale and securities-related borrowing (in euros, krona, and local currency); funding has tightened and become more costly.
  - Banks have switched in part to covered mortgage bonds with double collateral and longer average maturities.
- Market signals and stress indicators
  - Stock prices have dropped and credit default swap spreads have increased, notably for banks active in the Baltics.
  - Despite deterioration, system remains sound with 10 percent of banking assets at risk if banks with investment grade or lower credit rating default.
  - Default probability of Swedish banks remains low compared to other large banks, supported partly by robust corporate sector performance.
- Staff recommendations on capital and stress testing
  - Staff recommends that banks do not lower capital/asset ratios further (i.e., increase leverage), even though Basel II may allow them to do so given high share of mortgage lending with lower risk-weighting.
  - Stress tests: banks have sufficient buffers to cover loan losses up to 20 percent of total Baltic exposure while still meeting minimum CARs.
  - Staff encouraged stress-test scenarios to contemplate “tail” risks combining concurrent shocks (e.g., long stagnation in the Baltics with maintenance of currency pegs, or a recovery with valuation effects if a peg were adjusted).

### Financial Sector Surveillance — Bank supervision and resolution
- Supervision actions and gaps
  - The Financial Supervisory Authority (FSA) is enhancing cross-border supervisory cooperation with Scandinavian and Baltic partners, moving toward supervisory colleges in the Baltics.
  - Basel II implementation underway: eight banks have permission to use internal risk-based models.
  - Staff sees scope to use Pillar II and stress testing to bolster capital adequacy and recommends more on-site inspections of credit policies and portfolios and less reliance on auditors’ reports.
  - The FSA needs adequate resources to address high staff turnover.
- Remedial and resolution framework deficiencies and risks
  - Current bank resolution falls under regular corporate law, which is too slow for prompt remedial action and to meet payments system needs.
  - Responsibilities between the FSA, Riksbank, Deposit Insurance Agency, and fiscal authorities are not clear.
  - The 1990s crisis facilities are no longer in place; relying on a similar approach would be risky given larger, cross-border banks now more reliant on capital markets.
- Staff core recommendations for new framework (key features)
  - The FSA needs authority and tools to implement strict prudential measures in a coherent, comprehensive, step-by-step, graduated framework (from early consultation to decisive bank resolution measures).
  - Framework should be based on written code that defers to specialized courts to ensure timeliness of judicial oversight while preventing appeals from blocking supervisory decisions.
  - The framework should include all banks to avoid special treatment for systemic banks that would accentuate moral hazard and add legal complexity.
  - Immediately after a bank license is revoked, authorities should take effective control, replace management, and trigger the deposit guarantee.
  - Authorities should have a wide range of tools to wind up failing institutions, including partial sale of assets, arranging acquisition/merger with another bank, or other resolution tools.
  - To minimize moral hazard, owners of a failing bank should take the first hit; authorities should have the legal option to facilitate a merger into a stronger institution or redeem shares at a price corresponding to value in absence of state aid, subject to administrative procedures.
  - Legislation needs to prescribe a clear and credible priority of claims on bank assets, with potential losses for some creditors to discourage excessive risk taking.
- Authorities’ position
  - Authorities broadly agreed with staff recommendations but are investigating details: intent to keep legislation under corporate law while establishing specialized courts for quick resolution; consideration of invoking the framework only for systemic banks; assessment of legal possibilities vis-à-vis European law.

### Exchange Rate Surveillance
- Current regime and dynamics
  - The Swedish krona is freely floating as determined by market forces.
  - At constant REER, the external surplus would remain high and the IIP turn positive, bolstering net factor earnings; however, REER is expected to increase as fiscal tightening ends and policy interest rates are higher on average than in the past—supporting the krona and reducing over time the large current account surplus.
- Valuation assessments
  - CGER analysis suggests the krona is 10-15 percent below its expected medium-term value.
  - CPI and ULC REERs suggest similar conclusions.
- Box 2 — CGER estimates (key quantified findings)
  - Macroeconomic balance approach: Swedish (norm) current account surplus of 3.2 percent of GDP. Using Sweden-specific elasticities, the REER would need to appreciate 12 percent to lower the surplus to the norm.
  - Equilibrium real exchange rate approach: REER appears 16 percent below its estimated medium-term equilibrium value.
  - External sustainability approach: finds 23 percent undervaluation.
- Policy-mix implications
  - Interaction of tight fiscal policy and loose monetary policy contributed to a softer krona and a larger external balance.
  - The extended period of low interest rates contributed to higher domestic asset prices, rising wage demands, and a rebound in inflation.
  - Fiscal and monetary policies should recalibrate: fiscal policy has room to support domestic demand in a slowdown; monetary policy should be tight to lean against imported inflation and unwind elevated inflation expectations.
  - As domestic demand finds support and interest rates stay firm, the krona should strengthen and the external surplus should ease.

### Monetary Policy
- Framework and transparency
  - The Riksbank is an inflation targeter with a target of 2 percent CPI inflation with a margin of ± 1 ppt.
  - The Riksbank publishes policy committee minutes with attribution of individual members and a three-year inflation forecast and corresponding policy interest rate path; Sweden is one of the most transparent inflation targeters.
- Policy stance and timing
  - During 2003-07, the Riksbank kept policy rates below a CPI Taylor rule or inflation targeting rule.
  - The repo rate reached 4¼ percent in February 2008—assessed as late in the cycle.
  - The Riksbank emphasized steady rate increases since 2006 and that this was on target of policy rules using the CPIX (which excludes interest rates to prevent perverse policy feedbacks).
  - Since the mission, inflation increased further and the CPIX has been downgraded as underpredicting on-trend headline inflation; authorities now use several indicators to gauge pressure.
- Inflation and expectations
  - Inflation has jumped above 3 percent and is projected to come down gradually (CPI headline shown relative to target bands).
  - Inflation expectations for one-year ahead have increased above the upper inflation target band (money market managers, employees, purchasing managers data shown).
- Macro-financial interactions
  - As international conditions abated and resource utilization rose, inflation, core inflation, wage settlements and inflation expectations increased; house prices and credit to households accelerated and contributed to possible overvaluation relative to fundamentals.
  - The Riksbank’s policy normalization lag relative to ECB and Fed is noted in staff analysis.

*Source: IMF staff report content as provided in the supplied PDF excerpt.*

### 30. There was agreement that policy success means anchoring inflation expectations.

### _cr08278 - 30. There was agreement that policy success means anchoring inflation expectations.

### Monetary policy: anchoring inflation expectations
- Policy success was defined as anchoring inflation expectations.
- Inflation expectations are drifting up above the 2-percent target.
- The neutral policy rate is around 4¼ percent, and actual rates should oscillate around that level.
- Staff recommendation:
  - The repo rate should have an upward bias, weighing elevated inflation indicators against some relief from the economic slowdown.
  - Since current inflation pressures should not be allowed to slip into second round effects, consider a quarter point increase (noted later in the appraisal).
  - Policy should not ease until inflation expectations clearly break and broad indicators of capacity use and economic activity trend down.
- Authorities did not disagree with staff.

### Fiscal framework and rules
- Fiscal policy is subject to two rules:
  - (i) an average surplus of 1 percent of GDP over the cycle, and
  - (ii) an expenditure ceiling for central government and social security outlays.
- Local governments have little independent financing.
- The framework aims to address Sweden’s demographic transition and welfare commitments; it originated in reaction to the early-1990s deficits.
- The framework is valuable but implementation requires cyclical dating and is not fully anchored in a long-run analysis.

### 2008 Fiscal Policy Bill and near-term outlook
- The 2008 Fiscal Policy Bill aims the surplus at 2.9 percent of GDP, with further strengthening through 2011 on current policies.
- Centerpiece: a SEK11 billion expansion in the earned income tax deduction.
- Together with other measures, tax cuts are 0.6 percent of GDP.
- These tax cuts are offset by lower disability and other entitlement outlays—so that the structural surplus is little changed in 2008.
- On current policies, including these reforms and subindexing of some allocations, the authorities project a fiscal surplus of 4 percent of GDP by 2011.
- Given strong fiscal position and slowing growth, authorities are expected to offer fiscal support in the 2009 budget.
  - Expected measures: further income tax cuts and increased spending on infrastructure, R&D, and preschooling.
  - Staff view: stimulus should not exceed 1 percent of GDP.
  - Such support would not undermine Sweden’s strong fiscal stance and would be prudent given contingencies.

### Fiscal contingencies and risks
- Noted contingencies that counsel cautious fiscal policy:
  - Supply reforms, including entitlement cuts, could lead to substitution between programs or displacement of beneficiaries across government levels; net fiscal savings are difficult to estimate.
  - The earned income deduction is a variant of the earned-income tax credit; in some countries it has proven costly. Support for household services has met with great demand and could also turn out costly.
  - The sizeable surplus could trigger rent seeking and unproductive spending.
  - The slowdown, coupled with bank risks, could reduce revenue and lead to contingent fiscal needs.

### Fiscal measures to boost labor supply (Box 3)
- Measures include scaling back active labor market programs, tightening sickness and unemployment insurance schemes, and introducing job guarantees for young, long-term unemployed, and immigrants.
- Selected measures and years:
  - 2007:
    - New earned income deduction more generous for people aged 65+; interaction with income-dependent personal allowance de facto generates a reduced flat tax for incomes above SEK 110,000.
    - Reduction of nonpension social contributions for people aged 65+ (born after 1937).
    - Income tax credit on purchase of household services.
    - Introduction of New Start jobs in the commercial sector with elimination of employer social contributions for long-term unemployed, sick, and disabled (max. 5 years; preferential rules for young; double subsidy period for 55+).
    - Reduction of nonpension employer social contributions for people aged 18-25 by one half.
    - Introduction of Step-In jobs for immigrants with employer wage subsidies.
  - 2008:
    - Earned income deduction made more generous.
    - Elimination of nonpension contributions for all 65+.
    - Expansion of new start jobs to all sectors and introduction of well again jobs with stronger incentives for previously sick.
    - Harmonization of unemployment insurance contributions across funds.
- Assessment:
  - The earned income deduction removed important distortions in the marginal tax schedule, though some benefits may be offset by income effects varying along the income distribution.
  - Targeted incentive programs have so far provided ample net savings for the central government, but over time behavioral adaptation and displacement could reduce net savings.
  - If the economy stays strong, such offsetting effects should be limited.
  - Interaction of targeted and broad-based measures can complicate tax and benefit interactions and subtract from transparency; avoid multiplying narrowly targeted programs.
  - Authorities and stakeholders actively monitor and evaluate measures’ impact on employment, hours worked, and budgets at different government levels.

### Public sector balance sheet, aging costs, and long-run fiscal sustainability (Box 4)
- Staff explored a public sector balance sheet as a long-run fiscal anchor; Swedish bodies have called for fuller disclosure of public assets and liabilities.
- Intertemporal net worth—that captures long-run obligations—should be nonnegative.
- Aging cost estimates:
  - Authorities initially estimated aging costs for pensions, health, disability, unemployment, and education to be 2.2 percent of GDP between 2004-50.
  - More recent estimates put this figure even lower.
  - An independent staff evaluation suggests comprehensive aging costs could be as high as 8.0 percent of GDP, reflecting higher health care inflation and lower productivity growth with aging.
  - These differences are large; staff recommended an independent evaluation of forecasting models and assumptions for long-term aging costs and fiscal projections.
  - Monitoring over time should narrow differences and build comfort with analysis and policy implications; authorities concurred and would conduct further analysis.
- Public sector balance sheet findings:
  - Current net worth: staff estimated public sector capital stock to compute assets minus liabilities; Sweden’s current net worth is around 60 percent of GDP, higher than most rich countries.
  - Forward-looking position:
    - Constructed long-run potential output and, with the inflation target, a long-run nominal GDP path to project long-run fiscal balances under current policies and evolution of assets, liabilities, and net worth.
    - Net worth 50 years hence can be discounted to derive intertemporal net worth under maintained policies.
    - Sweden’s long run position is satisfactory if aging costs are contained at the lower bound; with low aging costs, the net worth constraint is amply met.
    - With high aging costs, the net worth constraint is just met but difficulties would emerge in due course.
    - Given wide-ranging aging cost estimates, further analysis using detailed authority data is needed.
  - Financial net worth: further analysis is needed to assess whether a more restricted net worth concept (excluding nonmarketable/non-liquid assets) would be a better indicator of long-run fiscal sustainability.

### Staff appraisal: risks, recommendations, and overall assessment
- Overall assessment:
  - The Swedish economy has performed well: output and employment growth have been high, inflation moderate, financial system functioning well, public finances solid, and external position favorable.
  - Sweden has addressed demographic challenges with pension reform and labor supply measures.
- Key risks and recommendations:
  - Strengthen financial system resilience before risks rise further; linkages between the financial system and the real economy are gaining importance.
  - Market signals indicate increasing banking risks: stock prices have dropped and credit default swap spreads have increased, particularly for banks active in the Baltics.
  - Banks should bolster resilience; authorities need to cement ability to deal with stress.
  - Sweden needs a dedicated remedial and resolution banking framework; the Ministry of Finance is working on a draft law and the effort should be completed sooner rather than later.
  - An FSAP update could identify remaining deficiencies and policy priorities to bolster financial sector resilience.
  - The krona is freely floating; staff expects gradual appreciation over the medium term and a decline in the current account surplus as saving-investment balance gravitates to equilibrium; a firmer krona would help lean against foreign price increases.
  - Inflation targeting framework is working well, but with energy and food price jumps inflation has risen above the upper band and core measures and expectations are picking up; short-term pressures should not be allowed to seep into second-round effects.
- Specific policy guidance reiterated:
  - Monetary policy should be biased upward. The repo interest rates is 4¼ percent—only neutral despite rising imported inflation and inflation expectations.
  - Since the mission visited Stockholm, inflation increased further and a quarter point increase should be considered.
  - Policy should not ease until inflation expectations clearly break and capacity-use and activity indicators trend down.
  - Fiscal policy: 2008 on track to produce a sound surplus with an approximately neutral fiscal impulse; outlook for 2009–2011 favorable under official projections assuming some constant nominal appropriations.
  - Sweden has fiscal room to respond to a slowdown: fiscal balance is running above 1 percent of GDP surplus over the cycle.
  - Staff supports reforms in the 2009 budget not exceeding 1 percent of GDP to cut taxes and increase public investment in infrastructure, R&D, and preschooling; these should strengthen long-run supply conditions.
  - Continue ambitious structural reform program to increase employment; limit distortions to benefit transparency and reduce compliance costs; evaluations of labor measures are welcome.
  - Government could include an intertemporal public sector balance sheet in Budget Bills, updated annually, with alternative scenarios on long-run productivity, growth, and aging costs; an independent body could prepare estimates of aging costs.

*Source: _cr08278 - 30. There was agreement that policy success means anchoring inflation expectations.*

### 51. It is recommended that Sweden remain on the 12-month Art. IV Consultation cycle.

### _cr08278 - 51. It is recommended that Sweden remain on the 12-month Art. IV Consultation cycle.

### Recommendation
- It is recommended that Sweden remain on the 12-month Art. IV Consultation cycle.

### Real economy (selected indicators and forecasts)
- Real GDP: 4.1 (2004), 3.3 (2005), 4.1 (2006), 2.7 (2007), 2.0 (2008), 1.7 (2009)
- Domestic Demand: 2.0 (2004), 3.2 (2005), 3.3 (2006), 4.3 (2007), 1.3 (2008), 1.9 (2009)
- CPI inflation: 1.0 (2004), 0.8 (2005), 1.5 (2006), 1.7 (2007), 3.4 (2008), 2.8 (2009)
- Unemployment rate (in percent): 6.3 (2004), 7.6 (2005), 7.0 (2006), 6.1 (2007), 6.6 (2008), 7.1 (2009)
- Gross national saving (percent of GDP): 23.1 (2004), 24.0 (2005), 26.6 (2006), 28.1 (2007), 27.4 (2008), 27.2 (2009)
- Gross domestic investment (percent of GDP): 16.4 (2004), 17.2 (2005), 18.1 (2006), 19.7 (2007), 19.9 (2008), 20.4 (2009)
- Potential Real GDP: 2.9 (2004), 3.1 (2005), 3.5 (2006), 3.4 (2007), 3.2 (2008), 2.8 (2009)
- Output Gap (as a percent of potential): 0.6 (2004), 0.7 (2005), 1.3 (2006), 0.7 (2007), -0.5 (2008), -1.6 (2009)

### Public finance (selected indicators and forecasts)
- General government balance (percent of GDP): 0.6 (2004), 2.0 (2005), 2.2 (2006), 3.4 (2007), 2.1 (2008), 1.0 (2009)
- Total Revenues (percent of GDP): 53.3 (2004), 54.4 (2005), 53.8 (2006), 53.4 (2007), 52.0 (2008), 50.7 (2009)
- Total Expenditures (percent of GDP): 52.7 (2004), 52.5 (2005), 51.6 (2006), 50.0 (2007), 50.0 (2008), 49.7 (2009)
- Structural balance (as a percent of potential GDP): 0.2 (2004), 1.1 (2005), 1.0 (2006), 2.0 (2007), 2.1 (2008), 2.3 (2009)
- General government gross debt (percent of GDP): 51.2 (2004), 50.9 (2005), 45.9 (2006), 40.6 (2007), 35.4 (2008), 31.2 (2009)

### Money, credit, and interest rates
- M0 (12-month, percent change): -0.2 (2004), 2.2 (2005), 0.4 (2006), 1.2 (2007)
- M3 (12-month, percent change): 4.0 (2004), 12.9 (2005), 15.0 (2006), 12.3 (2007)
- Credit to non-bank public (12-month, percent change): 6.1 (2004), 10.8 (2005), 11.2 (2006), 14.3 (2007)
- Repo rate (year average): 2.1 (2004), 1.7 (2005), 2.3 (2006), 3.5 (2007)
- Three-month treasury bill rate (year average): 2.1 (2004), 1.7 (2005), 2.3 (2006), 3.6 (2007)
- Ten-year government bond yield (year average): 4.4 (2004), 3.4 (2005), 3.7 (2006), 4.2 (2007)

### External sector and balance of payments
- Current account (percent of GDP): 6.7 (2004), 6.8 (2005), 8.5 (2006), 8.4 (2007), 7.5 (2008), 6.8 (2009)
- Trade balance (percent of GDP): 8.1 (2004), 7.3 (2005), 7.8 (2006), 7.3 (2007), 7.0 (2008), 6.1 (2009)
- Foreign Direct Investment, net (percent of GDP): -2.9 (2004), -4.5 (2005), 0.3 (2006), -3.9 (2007), -2.0 (2008), -2.0 (2009)
- International reserves (in billions of US dollars): 22.4 (2004), 26.5 (2005), 28.3 (2006), 30.5 (2007), 44.4 (2008), 50.8 (2009)
- Reserve cover (months of imports of goods and services): 2.0 (2004), 2.1 (2005), 2.0 (2006), 1.8 (2007), 2.2 (2008), 2.4 (2009)
- Exchange rate regime: Floating Exchange Rate; Skr per U.S. dollar (May 31, 2008): 6.0375
- Nominal effective rate (2000=100): 100.8 (2004), 98.7 (2005), 99.4 (2006), 101.6 (2007)
- Real effective rate (2000=100), based on relative unit labor costs in manufacturing: 90.2 (2004), 84.0 (2005), 82.8 (2006), 86.4 (2007)

### Fund position (as of May 31, 2008)
- Holdings of currency (in percent of quota): 92.30
- Holdings of SDRs (in percent of allocation): 82.67
- Quota (in millions of SDRs): 2,395.5

### Medium-term scenario and GDP components (2006–13 highlights)
- GDP (levels, in billions of 2000 kroner): 2,657 (2006), 2,729 (2007), 2,784 (2008), 2,831 (2009), 2,911 (2010), 2,998 (2011), 3,082 (2012), 3,160 (2013)
- Consumption (levels, in billions of 2000 kroner): 1,874 (2006), 1,918 (2007), 1,958 (2008), 2,000 (2009), 2,053 (2010), 2,107 (2011), 2,161 (2012), 2,214 (2013)
- Exports (levels, in billions of 2000 kroner): 1,433 (2006), 1,519 (2007), 1,607 (2008), 1,645 (2009), 1,716 (2010), 1,802 (2011), 1,889 (2012), 1,973 (2013)
- Imports (levels, in billions of 2000 kroner): 1,128 (2006), 1,236 (2007), 1,321 (2008), 1,370 (2009), 1,452 (2010), 1,545 (2011), 1,638 (2012), 1,727 (2013)
- Potential GDP (in billions of 2000 kroner): 2,622 (2006), 2,711 (2007), 2,799 (2008), 2,879 (2009), 2,955 (2010), 3,028 (2011), 3,095 (2012), 3,160 (2013)
- Output Gap (as a percent of potential): 1.3 (2006), 0.7 (2007), -0.5 (2008), -1.6 (2009), -1.5 (2010), -1.0 (2011), -0.4 (2012), 0.0 (2013)

### Financial system structure (2002–07) — concentration and assets
- Total financial system assets (2007): 15,122.3 (bn SEK) — 100.0 percent of financial system
- Total banking sector assets (2007): 10,823,268 (mio SEK) — 71.6 percent of financial system; percent of GDP: 352.1
- Four major banks (consolidated) total assets (2007): 9,491,189 (mio SEK) — 62.8 percent of financial system; percent of GDP: 392.1
- Mutual funds total assets (2007): 1,416,210 (mio SEK) — 9.4 percent of financial system; percent of GDP: 46.1
- Insurance companies total assets (2007): 2,542,983 (mio SEK) — 16.8 percent of financial system; percent of GDP: 82.7

### Financial soundness indicators: Banks (2003–07)
- Regulatory capital to risk-weighted assets: 10.5 (2003), 10.6 (2004), 10.5 (2005), 10.5 (2006), 10.2 (2007)
- Regulatory Tier I capital to risk-weighted assets: 8.0 (2003), 8.3 (2004), 7.7 (2005), 7.8 (2006), 7.5 (2007)
- Capital as percent of assets (leverage ratio): 5.1 (2003), 4.8 (2004), 4.8 (2005), 4.8 (2006), 4.7 (2007)
- Nonperforming loans to total gross loans: 2.0 (2003), 1.2 (2004), 0.9 (2005), 0.8 (2006), 0.6 (2007)
- Return on assets: 0.6 (2003), 0.7 (2004), 0.8 (2005), 0.8 (2006), 0.8 (2007)
- Return on equity: 12.5 (2003), 15.9 (2004), 18.1 (2005), 19.9 (2006), 18.5 (2007)
- Liquid assets as percent of total assets: 4.4 (2003), 5.2 (2004), 5.0 (2005), 5.0 (2006), 5.0 (2007)
- Noninterbank loans to noninterbank deposits: 142.6 (2003), 130.8 (2004), 137.4 (2005), 135.7 (2006), 139.8 (2007)
- Foreign currency-denominated loans as percent of total loans: 30.0 (2003), 28.0 (2004), 28.0 (2005), 32.3 (2006), 34.6 (2007)

### Financial soundness indicators: Non-banks and sectoral metrics (2003–07)
- Solvency ratio (margin/required margin) — Life insurance companies: 9.0 (2003), 8.4 (2004), 11.2 (2005), 13.8 (2006), 14.9 (2007)
- Households: Household debt to banks as percent of GDP: 59.2 (2003), 62.1 (2004), 66.2 (2005), 69.2 (2006), 71.7 (2007)
- Household debt service and principal payments as percent to income: 3.8 (2003), 3.5 (2004), 3.4 (2005), 3.6 (2006), 4.4 (2007)
- Corporate sector: Debt stock as percent of GDP: 47.5 (2003), 45.6 (2004), 48.3 (2005), 49.1 (2006), 55.1 (2007)
- Residential real estate prices (y-o-y change): 6.1 (2003), 10.0 (2004), 10.5 (2005), 10.5 (2006), 11.3 (2007)

### Balance of payments accounts (2006–13 highlights)
- Current Account Balance (in billions of krona): 245 (2006), 256 (2007), 244 (2008), 230 (2009), 224 (2010), 227 (2011), 233 (2012), 244 (2013)
- Trade Balance (in billions of krona): 225 (2006), 223 (2007), 226 (2008), 205 (2009), 186 (2010), 174 (2011), 165 (2012), 160 (2013)
- Exports of G&S (in billions of krona): 1,462 (2006), 1,570 (2007), 1,709 (2008), 1,766 (2009), 1,822 (2010), 1,911 (2011), 2,017 (2012), 2,128 (2013)
- Imports of G&S (in billions of krona): 1,237 (2006), 1,348 (2007), 1,483 (2008), 1,560 (2009), 1,636 (2010), 1,736 (2011), 1,852 (2012), 1,969 (2013)
- Financial Account Balance (percent of GDP): -8.7 (2006), -5.0 (2007), -7.5 (2008), -6.7 (2009), -6.2 (2010), -6.0 (2011), -5.9 (2012), -5.9 (2013)
- Investment Abroad (percent of GDP): -20.5 (2006), -21.1 (2007), -8.8 (2008), -8.0 (2009), -7.6 (2010), -7.4 (2011), -7.2 (2012), -7.2 (2013)
- Reserves (percent of GDP): -0.4 (2006), 0.1 (2007), -2.0 (2008), -1.2 (2009), -0.7 (2010), -0.5 (2011), -0.4 (2012), -0.4 (2013)

### International Investment Position (2006–13 highlights)
- Swedish Assets Abroad (in billions of krona): 6,312 (2006), 7,276 (2007), 7,989 (2008), 8,639 (2009), 9,306 (2010), 9,998 (2011), 10,718 (2012), 11,470 (2013)
- Swedish Liabilities Abroad (in billions of krona): 6,666 (2006), 7,490 (2007), 7,978 (2008), 8,414 (2009), 8,872 (2010), 9,354 (2011), 9,858 (2012), 10,385 (2013)
- International Investment Position (in billions of krona): -354 (2006), -215 (2007), 11 (2008), 254 (2009), 346 (2010), 448 (2011), 601 (2012), 1,086 (2013)
- International Investment Position (as a percent of GDP): -12.2 (2006), -7.0 (2007), 0.3 (2008), 6.7 (2009), 12.2 (2010), 17.3 (2011), 22.0 (2012), 26.5 (2013)

### General government financial accounts (2006–13 highlights)
- Total Revenue (in billions of krona): 1,560 (2006), 1,640 (2007), 1,685 (2008), 1,716 (2009), 1,801 (2010), 1,901 (2011), 2,002 (2012), 2,101 (2013)
- Total Expenditure (in billions of krona): 1,496 (2006), 1,535 (2007), 1,616 (2008), 1,683 (2009), 1,752 (2010), 1,822 (2011), 1,897 (2012), 1,970 (2013)
- Primary balance (in billions of krona): 116 (2006), 162 (2007), 123 (2008), 85 (2009), 101 (2010), 128 (2011), 151 (2012), 172 (2013)
- Overall Balance (in billions of krona): 63 (2006), 105 (2007), 69 (2008), 33 (2009), 49 (2010), 79 (2011), 105 (2012), 131 (2013)
- Structural Balance (percent of GDP): 1.0 (2006), 2.0 (2007), 2.2 (2008), 2.3 (2009), 2.5 (2010), 2.9 (2011), 3.0 (2012), 3.2 (2013)
- Fiscal Impulse (expansionary +): 0.0 (2006), -1.0 (2007), -0.1 (2008), -0.1 (2009), -0.3 (2010), -0.3 (2011), -0.1 (2012), -0.2 (2013)
- Gross Public Debt (percent of GDP): 45.9 (2006), 40.6 (2007), 36.4 (2008), 33.8 (2009), 30.9 (2010), 27.3 (2011), 23.3 (2012), 19.1 (2013)
- Nominal GDP (in billions of SEK): 2,900 (2006), 3,071 (2007), 3,238 (2008), 3,386 (2009), 3,550 (2010), 3,730 (2011), 3,911 (2012), 4,090 (2013)

### Public sector balance sheet and aging scenarios (selected items)
- Aging costs (percent of GDP) — two scenarios: 2.2 and 8.0
- Assets (in billions of SEK): 2,610 (2003), 2,754 (2004), 2,995 (2005), 3,307 (2006), 3,466 (2007)
- Liabilities (in billions of SEK): 1,618 (2003), 1,680 (2004), 1,762 (2005), 1,657 (2006), 1,588 (2007)
- Current net worth (in billions of SEK): 992 (2003), 1,074 (2004), 1,233 (2005), 1,650 (2006), 1,878 (2007)
- NPV of future fiscal policies (50 years) — 1,989 (2003), 2,046 (2004), 2,034 (2005), 1,788 (2006), 1,752 (2007)
- Intertemporal net worth (in billions of SEK): 2,981 (2003), 3,120 (2004), 3,267 (2005), 3,438 (2006), 3,630 (2007)

### Fund relations, Article IV consultation, and outreach
- Membership status: Joined 08/31/1951; Article VIII
- Quota: 2,395.50 (SDR Million) — 100.00 percent of quota
- Fund holdings of currency: 2,111.15 (SDR Million) — 92.30 percent of quota
- Net cumulative SDR allocation: 246.53 (SDR Million) — 100.00 percent of allocation
- Holdings of SDRs: 203.79 (SDR Million) — 82.67 percent of allocation
- Outstanding Purchases and Loans: None
- Financial Arrangements: None
- Projected charges/interest (SDR Million): 0.62 (2008), 1.29 (2009), 1.29 (2010), 1.29 (2011), 1.29 (2012)
- Exchange arrangements: The Krona has been floating freely since November 19, 1992. Sweden has accepted the obligations of Article VIII (Sections 2(a), 3, and 4) and maintains an exchange system free of restrictions on payments and transfers for current international transactions, apart from those imposed for security reasons, as notified to the Fund by the Riksbank (EBD/06/79, June 23, 2006).
- 2008 Article IV Consultation: A staff team visited Stockholm during May 23–June 2, 2008. Outreach included meetings with the labor federation, the employers association of industry, the four largest banks, think tanks, members of the Riksdag Finance Committee, and the Fiscal Policy Council. A press conference was held in the Riksbank after the concluding meeting. The staff report will be published.
- Last Article IV Consultation: Discussions for the 2007 Article IV consultation were held in Stockholm on November 7-14, 2006; staff report issued February 7, 2007 (IMF Country Report 07/52); consultation concluded by the Executive Board on January 26, 2007.
- Technical assistance: LEG and MCM provided technical assistance on bank resolution frameworks (Aide Memoire, March 16, 2007).
- Resident Representative: None

*Source: IMF staff report content (as presented in the supplied PDF content).*

### 1.      This statement provides information that has become available since the circulation of

### _cr08278 - 1.      This statement provides information that has become available since the circulation of

### Summary update
- This statement provides information that has become available since the circulation of the staff report for the 2008 Article IV Consultation.
- It does not alter the thrust of the staff appraisal.

### Inflation
- Inflation rose to 4.3 percent in June (higher than expected by the authorities, staff, and other analysts), and is now at its highest level since the mid-1990s.

### Monetary policy
- In response, the Riksbank raised its policy interest rate by 25 basis points to 4.5 percent, and raised its interest rate path forecast—i. e. signaling an upward bias for the near term.
- The minutes of the policy meeting reveal that some committee members would have preferred to retain a neutral stance, on expectations that the slowing economy will soon start to reduce inflation.

### Labor market
- The labor force survey for June indicated that employment in persons and hours worked continued to increase year-on-year, but unemployment nevertheless ticked up noticeably, especially for younger workers.

### Confidence
- Consumer and business confidence both declined in June based on concerns about employment prospects, the continued high energy and food prices, and the slowing external environment.

*This statement provides information that has become available since the circulation of the staff report for the 2008 Article IV Consultation.*

### 6.      Banking developments. SEB and Swedbank, the dominant Swedish banks in the

### _cr08278 - 6.      Banking developments. SEB and Swedbank, the dominant Swedish banks in the

### Banking developments and risks
- SEB and Swedbank, the dominant Swedish banks in the Baltics, "surprised with profits on the upside in the second quarter of 2008."
- Loan impairment is rising (from low levels).
- Funding conditions and market sentiment have weakened over time.
- Swedbank was downgraded by Moody’s, reflecting its large exposure to the slowing regional economies.
- Directors noted market signals indicating increased banking risks and stressed the importance of sound bank management, supervision, and regulation.
- The banks’ Baltic exposures account for a considerable part of total earnings and lending, making banks vulnerable to Baltic economic developments.

### Macroeconomic performance and outlook
- Growth and labor market
  - Employment growth reached 2 percent.
  - Unemployment rate declined from 8 percent in 2005 to 6 percent in early 2008.
  - Staff baseline forecast: economy expected to slow to 2 percent in 2008 and 1¾ percent in 2009.
- Inflation and monetary policy
  - Inflation increased from ½ percent in 2005 to 4 percent in May 2008.
  - Core inflation rose to 2.9 percent.
  - The Riksbank has gradually raised the policy rate to 4.50 percent in July 2008.
  - Directors welcomed the Riksbank’s recent increase in the policy rate and urged monetary policy to remain as firm as needed to break inflation expectations.
- External position
  - With strong fiscal adjustment and high private savings, the external current account surplus reached 8 percent of GDP.
  - Trade surplus is 7 percent of GDP.
  - Growing net external assets and favorable returns contributed net factor payments of 2 percent of GDP.
  - Sweden’s large foreign aid budget contributes outflows in excess of 1 percent of GDP.

### Executive Board assessment and recommended actions
- Overall assessment
  - Directors commended Sweden for strong economic performance: high output and employment growth, moderate inflation, well-functioning financial system, solid public finances, and favorable external position.
  - Main challenges: continue strengthening financial system resilience and firmly anchor inflation expectations.
- Financial sector recommendations
  - Encourage completion of the draft law on a new banking resolution framework as soon as possible and recommend comprehensive application.
  - Welcome progress on FSAP recommendations and suggest an FSAP Update to identify further measures to bolster financial sector resilience.
  - Stress importance of adequate resources and right focus for the supervisory authority (FSA); noted FSA resources were increased by more than 10 percent for 2008.
- Fiscal and structural policy recommendations
  - Fiscal policy: welcome exemplary fiscal performance and note fiscal room to respond to a slowdown; 2009 budget could include targeted tax cuts and moderate increases in public investment in infrastructure, Research and Development, and pre-schooling.
  - Directors saw merit in pursuing an intertemporal public sector balance sheet, updated annually, to increase transparency and inform policy.
  - Structural reforms: continue pursuing labor taxation reforms to increase employment; evaluate labor supply measures to ensure intended effects.
  - Caution: targeted programs should be limited to benefit transparency; monitor costs of earned income deduction and tax credit for household services.

### Scenarios and risk channels
- Upside scenario
  - If funding costs normalize and the Baltics achieve a soft landing, stable credit expansion should support growth.
- Downside scenario
  - If turmoil persists, Swedish housing prices fall, or Baltic exposures sour, a credit crunch could slow growth below the forecast.
- Directors emphasized that increased interconnectedness could accentuate shocks and spillovers.

### Key statistics and projections (selected figures preserved exactly as in source)
- Growth and demand
  - Real GDP: 2004: 4.1; 2005: 3.3; 2006: 4.1; 2007: 2.7; 2008: 2.0 (Est./Forecast); 2009: 1.7 (Est./Forecast)
  - Domestic Demand: 2004: 2.0; 2005: 3.2; 2006: 3.3; 2007: 4.3; 2008: 1.3; 2009: 1.9
  - CPI inflation: 2004: 1.0; 2005: 0.8; 2006: 1.5; 2007: 1.7; 2008: 3.4; 2009: 2.8
  - Unemployment rate (in percent): 2004: 6.3; 2005: 7.6; 2006: 7.0; 2007: 6.1; 2008: 6.6; 2009: 7.1
  - Gross national saving (percent of GDP): 2004: 23.1; 2005: 24.0; 2006: 26.6; 2007: 28.1; 2008: 27.4; 2009: 27.2
  - Gross domestic investment (percent of GDP): 2004: 16.4; 2005: 17.2; 2006: 18.1; 2007: 19.7; 2008: 19.9; 2009: 20.4
  - Potential Real GDP: 2004: 2.9; 2005: 3.1; 2006: 3.5; 2007: 3.4; 2008: 3.2; 2009: 2.8
  - Output Gap (as a percent of potential): 2004: 0.6; 2005: 0.7; 2006: 1.3; 2007: 0.7; 2008: -0.5; 2009: -1.6
- Public finance (percent of GDP)
  - General government balance: 2004: 0.6; 2005: 2.0; 2006: 2.2; 2007: 3.4; 2008: 2.1; 2009: 1.0
  - Total Revenues: 2004: 53.3; 2005: 54.4; 2006: 53.8; 2007: 53.4; 2008: 52.0; 2009: 50.7
  - Total Expenditures: 2004: 52.7; 2005: 52.5; 2006: 51.6; 2007: 50.0; 2008: 50.0; 2009: 49.7
  - Structural balance (as a percent of potential GDP): 2004: 0.2; 2005: 1.1; 2006: 1.0; 2007: 2.0; 2008: 2.1; 2009: 2.3
  - General government gross debt: 2004: (blank); 2005: 51.2; 2006: 50.9; 2007: 45.9; 2008: 40.6; 2009: 35.4; 2010: 31.2 (note: table entries presented through 2009 with 31.2 shown)
- Money, credit, and interest rates
  - M0 (12-month, percent change): 2004: -0.2; 2005: 2.2; 2006: 0.4; 2007: 1.2
  - M3 (12-month, percent change): 2004: 4.0; 2005: 12.9; 2006: 15.0; 2007: 12.3
  - Credit to non-bank public (12-month, percent change): 2004: 6.1; 2005: 10.8; 2006: 11.2; 2007: 14.3
  - Repo rate (year average): 2004: 2.1; 2005: 1.7; 2006: 2.3; 2007: 3.5
  - Three-month treasury bill rate: 2004: 2.1; 2005: 1.7; 2006: 2.3; 2007: 3.6
  - Ten-year government bond yield: 2004: 4.4; 2005: 3.4; 2006: 3.7; 2007: 4.2
- Balance of payments (percent of GDP)
  - Current account: 2004: 6.7; 2005: 6.8; 2006: 8.5; 2007: 8.4; 2008: 7.5; 2009: 6.8
  - Trade balance: 2004: 8.1; 2005: 7.3; 2006: 7.8; 2007: 7.3; 2008: 7.0; 2009: 6.1
  - Foreign Direct Investment, net: 2004: -2.9; 2005: -4.5; 2006: 0.3; 2007: -3.9; 2008: -2.0; 2009: -2.0
  - International reserves (in billions of US dollars): 2004: 22.4; 2005: 26.5; 2006: 28.3; 2007: 30.5; 2008: 44.4; 2009: 50.8
- Exchange rate
  - Exchange rate regime: Floating Exchange Rate
  - Skr per U.S. dollar (May 31, 2008): 6.0375
  - Nominal effective rate (2000=100): 2004: 100.8; 2005: 98.7; 2006: 99.4; 2007: 101.6
  - Real effective rate (2000=100, ULC based): 2004: 90.2; 2005: 84.0; 2006: 82.8; 2007: 86.4
- Fund position (May 31, 2008)
  - Holdings of currency (in percent of quota): 92.30
  - Holdings of SDRs (in percent of allocation): 82.67
  - Quota (in millions of SDRs): 2395.5
- Social indicators (reference year)
  - GDP per capita (in current PPP US dollars, 2006): 31,062
  - Income Distribution (ratio of income received by top and bottom quintiles, 2005): 3.3
  - Life expectancy at birth (2005): 78.4 (males) and 82.9 (female)
  - Automobile ownership (2004): 456 per thousand
  - CO2 Emissions (tonnes per capita, 2003): 5.6
  - Population Density (inhabitants per sq. km., 2005): 22
  - Poverty Rate (share of the population below the established risk-of-poverty line, 2005): 9 percent

*Public Information Notice (PIN) No. 08/105  FOR IMMEDIATE RELEASE  August 11, 2008*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08278.pdf_